The Lowdown from Investment Quorum

November 19th, 2018

Global Markets to 19 November 2018 Highlights Brexit dominates the financial markets as the UK Prime Minister reaches a technical agreement with the European Union. But this comes at a cost: a number of ministerial resignations and fierce criticism of the deal weaken the Prime Minister’s hand and position as leader of the Conservative party. […]

Global Markets to 19 November 2018

Highlights

Brexit dominates the financial markets as the UK Prime Minister reaches a technical agreement with the European Union.

But this comes at a cost: a number of ministerial resignations and fierce criticism of the deal weaken the Prime Minister’s hand and position as leader of the Conservative party.

Continuing concerns over the Italian budget are overshadowed by Brexit, but Rome’s stubbornness regarding its fiscal plans could pave the way for a further clash with Brussels.

On the FX markets, sterling remains volatile, reflecting ever-changing developments in relation to the Brexit treaty, while the euro gains ground against both the pound and the US dollar.

Further volatility on the oil market sees the price of Brent crude tumble by more than 6% on Tuesday, hitting a point 22% below the four-year high that it reached in October.

Global equity markets remain volatile, continuing to struggle with so much uncertainty.

Global Market Summary

It was a significant week for Brexit negotiations: the European Union and UK Prime Minister Theresa May agreed to a 585-page draft deal which initially won the Cabinet’s backing. However, the Cabinet ultimately less united over the deal, leading to further high-profile ministerial resignations. There are now significant doubts as to whether or not the deal will be voted through by Parliament, which raises the prospect of a “hard Brexit” and no deal with Europe and the possibility of a leadership battle in the Conservative party.

The Prime Minister held a press conference outlining the deal’s details, indicating that the UK had a choice between her deal, no deal… or no Brexit at all. This Brexit deal announcement and the ensuing resignations sparked a fall in the value of sterling and a sell-off in many UK companies’ share prices. Banks, house builders and retailers were hit the hardest. Indeed, UK estate agent Foxtons announced that it would be closing six of its London branches: it is struggling to sell homes in what it described as “a very challenging property market”. This is clearly a corollary of Brexit.

Conversely, however, companies with substantial foreign earnings exposure gained ground as investors rushed in to “buy-on-the-Brexit-dip”. It seems fairly certain that with so much weighing on the eventual outcome of Brexit (and the possibility of a Tory leadership election), both the UK stock market and sterling will continue to be volatile.

Brexit is a complex and disruptive issue. Indeed, what people commonly understand by the terms “soft” and “hard” Brexit appears to have changed since the June 2016 referendum. Initially, a soft Brexit referred to the UK opting for a Norwegian-style relationship with the EU, while a hard Brexit meant leaving on World Trade Organisation terms or opting for a Canada-style trade deal.

Now, nearly two years on, these terms mean something completely different. Will the UK leave with a deal that provides a smooth transition with some form of future trading relationship with the European Union, or will the UK crash out of the EU with no deal at all? Things currently look somewhat grim, but an exit deal being struck would seem the most likely outcome.

It is quite impossible to predict the outcome or indeed how things might play out over the next few weeks. The Prime Minister currently seems to be fighting on three fronts: firstly, she is trying to get her Brexit deal accepted; secondly, she faces the growing prospect of a leadership context; and thirdly, she faces the likelihood of her Brexit deal being voted down by Parliament. Very few people will wish to embrace the chaos that a no-deal Brexit might create, and such an outcome is in the best interests of neither the United Kingdom nor the European Union.

The UK government obviously has further difficulties ahead of it and will most likely find itself staring into the abyss before eventually taking decisive steps to avoid total disaster. Needless to say, this will mean a further period of volatility for the UK stock market and sterling.

Elsewhere in Europe, the Italian government’s 2019 budget proposal seems to have fallen on deaf ears in Brussels as Rome continues to play hardball with the European Union. Unfortunately, this situation looks set to become significantly more complicated, and there is a chance that the Italian government will consider leaving the EU and introducing its own currency if an agreement cannot be found.

As a key member of the European Union, Italy is likely to push hard for greater spending. The EU is trying to get Rome to concede, and since Europe is currently negotiating on two fronts (Brexit and the Italian budget), this will mean continuing volatility across European equity and bond markets.

Another factor affecting the markets has been the unpredictability of crude oil prices. Back in October, they reached a four-year high, but have subsequently fallen by 22% on supply and demand issues. This is a double-edged sword: nations such as Indonesia, Japan and India benefit from weaker oil prices as they are large oil importers; Russia, Saudi Arabia, Mexico and Brazil, on the other hand, face more challenging times as exporting countries.

To conclude, a slowing global economy (with the exception of the US) has been a challenge in recent months for global investors, commodities, bond and equity markets. This was very much in evidence last week when both Japan and Germany reported larger-than-predicted contractions on their respective economies for the third quarter of the year. Concerns over Germany – the EU’s largest economy – are clearly justified: it has suffered its first quarterly contraction in more than three years as exports to China fell, possibly reflecting the first effects of the trade war.

Many analysts will now be trying to determine whether the weakening global economy will begin to weigh heavier on the US and affect the Federal Bank’s monetary tightening programme. Indeed, many believe that it will further raise interest rates in December, with three more hikes to follow in 2019.

But the US economy is still in good shape, with a tight job market and a healthy corporate earnings outlook. This is very much in evidence in the performance of the MCSI World Index, which is down by just over 3%; if the US is extracted, it is down by over 11% this year.

As far as our current asset allocation strategy is concerned, we continue to support equities over bonds on a long-term investment time horizon. However, we fully believe that over the coming weeks, the bond and equity markets will continue to be characterised by a great deal of volatility – particularly since there is so much uncertainty affecting market sentiment at the moment, and as the global economies transition towards higher interest rates and the winding down of quantitative easing.

Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment committee.

This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.

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